A short reflection on European financial criminal law
Today’s guest writer for the Rotterdam Criminology Blog is Mathijs Giltjes, a PhD Candidate from Erasmus School of Law who researches high frequency trading and market abuse. Although our guest writer primarily adopts a legal perspective, this blog post carries important criminological relevance in relation to technology and cybercrime, and the challenges of establishing effective criminal justice system responses to crimes of the powerful.
On 28 January 2020, 41-year-old Navinder Singh Sarao, the shy former whizz-kid who was ironically dubbed the Hound of Hounslow for allegedly causing the Flash Crash of 6 May 2010, was sentenced to time served and a year of home detention back in the UK. After being extradited to the US, Navinder pled guilty to charges of wire fraud and ‘spoofing’. The latter refers to the sending and cancelling of trade orders to the trading platform’s electronic order book without the intent of executing them; a tactic used to tempt traders to follow a lead, tricking them into believing that there is some momentum or information to profit from. Both wire fraud and spoofing constitute market manipulation and are banned under US as well as EU law. During the Flash Crash, which was believed to be accelerated by high frequency (‘HF’) traders, one trillion dollars momentarily evaporated from the US capital markets.
HF trading is the hyper-fast trading of vast amounts of securities, where orders are initiated, sent, routed, executed, modified and/or cancelled by algorithmically programmed computers, with little to no human intervention. Recently, the UK Financial Conduct Authority estimated that just the sole HF trading strategy called ‘latency arbitrage’ already rakes in billions of dollars per year globally. Indeed, HF trading is not merely a US phenomenon. HF traders also dominate the European securities markets. Noteworthy, the Netherlands offers home to some of the biggest HF traders on the European continent, such as Flow Traders, Optiver and IMC. Whereas HF trading offers opportunities to more effectively implement trading strategies, it might at the same time also give rise to new or more developed forms of market manipulation. Market manipulators illicitly profit from their counterparties, such as retail investors and institutional investors like pension funds and life insurance companies, and harm a market’s integrity, resulting in less economic growth and fewer employment opportunities.
Navinder, a ‘quant’ who supposedly perceives securities trading as one big statistics game and who has never exhibited any interest in material things such as money, developed and deployed numerous, admittedly, brilliant trading programs and strategies to systematically beat his opponent traders. Yet, the Securities Exchange Commission and the Commodity Futures Trading Commission, the US regulatory bodies tasked with overlooking the securities markets, were less appreciative of Navinder’s brilliance. They claimed that Navinder, by rapid-firing his computer-programmed artillery, illegally earned tens of millions of dollars. Because of the severity of the facts, including the tens of millions of dollars of illicit gains as well as allegedly causing the Flash Crash, Navinder was charged under criminal law rather than brought to trial on the basis of an administrative (or civil) action—a procedure more common in US market manipulation cases.
Similar to the US, market manipulation in the EU is commonly sanctioned through administrative penalties. Although the 2014 Market Abuse Directive (‘MAD II’), alongside the more administrative law-oriented Market Abuse Regulation (‘MAR’), ensures the availability of criminal sanctions to combat ‘serious’ forms of market manipulation, it remains questionable whether it provides a sufficient basis to more effectively safeguard the EU securities markets against malpractice by HF traders. This blog post therefore raises the question: what is the added value of the EU financial criminal law framework provided by MAD II with respect to market manipulation-related HF trading?
HF trading is the result of the natural evolution of trading and trading platforms maturing into the faster, more advanced and technology focused modern era. The technologization, deregulation, proliferation, fragmentation and globalization of trading and trading platforms have shaped the perfect environment for HF trading. HF traders deploy numerous complex algorithms in an attempt to systematically beat the markets, for example by sifting out and acting on relevant market information exhibited by informed traders. To that end, they quite literally place their trading computers right next to the trading venues’ matching engines, hire the most promising traders and tech people (typically mathematicians, econometricians and computer scientists), and buy or develop the most advanced software and hardware to run their algorithms. Long gone are the tiresome days when one had to call a broker to execute a trade, having to wait hours or days until it was completed. Today, trading occurs at a pace approaching the speed of light, and time advantages in trading are measured in more extreme granular timeframes, where a thousandth, millionth and even a billionth of a second matters.
Not so long ago, the 2008 financial crisis painfully exposed the weaknesses of our financial (legal) systems. This crisis urged policymakers worldwide to adopt new legislation in an attempt to mitigate the crisis’s ramifications (e.g. the Dodd-Frank Act, CRD IV and CRR). Unfortunately, these legal statutes were not enacted until after the risks posed by the financial markets materialized. Today, the securities markets are bigger, faster and more interconnected than ever. Although this is the result of a natural evolution, it also significantly increases systemic risks: for example, think of a manipulative algorithm that goes haywire and causes an entire market to explode (or implode). Given the velocity at which trading takes place, it has even been suggested that the financial systems of today are ‘too fast to save’ (Lin 2016, p. 1389-1392). With the psychological and societal impact of the 2008 financial crisis still fresh in the world’s collective memory, we ought to evaluate the (financial) legal system before another crisis or crash occurs.
Currently, market manipulation is defined by general and arguably vague terms in Article 12 MAR, and banned on the basis of Article 15 MAR. If this ban is violated, suspects are typically sanctioned through administrative penalties by the competent authorities of the Member States. However, violations of the ban can also be sanctioned through criminal charges, and the Member States are in fact required to establish criminal offences for at least ‘serious’ forms of market abuse. Serious forms of market manipulation include behavior where the impact on market integrity, derived profit, avoided loss, or level of damage caused to the market is high. Admittedly, this provides little concrete guidance (for example, when is the impact on market integrity ‘high’?), and the Member States have the freedom to establish criminal offences for less serious forms of market manipulation, possibly giving rise to regulatory fragmentation. Furthermore, these serious forms of market manipulation should at least constitute criminal offences when committed with intent. Hence, this ‘intent requirement’ also provides a minimum, and the Member States are allowed to opt for a lower threshold.
The financial criminal law sanctions provided by MAD II, which are to be implemented by its Member States, supposedly demonstrate a stronger form of social disapproval compared to the administrative penalties provided by MAR, and provide a potentially important tool to combat financial harms because it makes it possible to use more effective methods of investigation and enables improved cooperation within and between the Member States. Especially considering that the trading landscape is scattered over the Member States, this could be a helpful contribution to the investigation and prosecution of HF-trading related market manipulation. In the current algorithm-driven era of trading, however, where storing and analyzing possibly incriminating data could require enormous data farms, it is tremendously difficult to even qualify certain practices or behavior as market manipulation in the sense of Article 12 MAR, and sanction these through administrative law, let alone to qualify these as ‘serious’ criminal behavior or prove a level of criminal intent. For these reasons, although the rationale behind the financial criminal law framework provided by MAD II is admirable, I argue that criminally charging HF trading-related market manipulation is an extremely challenging task. For example, I would be very interested in witnessing MAD II’s effectiveness if a crash similar to the Flash Crash took place in the European Union as a result of market manipulative practices of one or more HF traders. Although such a crash would probably be ‘serious’, it remains questionable whether the practices resulting in this crash can be qualified as (a serious form of) market manipulation in the sense of Article 12 MAR, and whether the intent requirement or lower threshold can be met.
In the US, the alleged culprit of the Flash Crash was convicted on the basis of financial criminal law. By choosing criminal sanctions over administrative penalties, this increased the perceived seriousness of the trading practices deployed and (arguably) the deterrent effect of the sanctions imposed. Amongst others, imposing criminal sanctions on natural persons might even prove itself significantly more effective than imposing these sanctions on legal persons (Cosme Jr. 2019, p. 387-390). Although much controversy about Navinder’s role in the Flash Crash remains, Navinder’s prosecution provides food for thought on our side of the Atlantic. What is the role of financial criminal law in combatting HF trading-related market manipulation? I think it would be worthwhile to assess the added value of MAD II in the HF-trading and future eras. For one, I think the intent requirement should be a sufficient but not a necessary requirement to prosecute manipulative practices entertained by HF traders. Could one prove an algorithm, or its developer, had the intent to manipulate the market? Probably not, especially given the fact that most algorithms react to one another and to changing market conditions, making it even more difficult to find the market manipulation’s initiator.
Although criminal charges against HF trading-related malpractices have yet to be pressed in Europe, I wonder whether the implementation of MAD II will be enough to prosecute individuals engaged in criminal behavior of this nature. Nonetheless, I wish good luck to those who are brave enough to try.
 For estimates of their presence, see ESMA, High-frequency trading in EU equity markets, 2014, p. 11 and ESMA, Order duplication and liquidity measurement in EU equity markets, 2016, p. 13. Nevertheless, due to the absence of a clear-cut definition of HF trading, it is difficult to estimate its exact presence. See, amongst others, D. Busch, ‘MiFID II: regulating high frequency trading, other forms of algorithmic trading and direct electronic market access’, 10 Law and Financial Markets Review 2016, p. 74-75. In academic scholarship a myriad of different characteristics has been used to distinguish between HF trading and non-HF trading. For early overviews, see Gomber et al., ‘High-Frequency Trading’, 2011, p. 74-82 available through SSRN (papers.ssrn.com/sol3/papers.cfm?abstract_id=1858626) and A.J. Menkveld, ‘The Economics of High-Frequency Trading: Taking Stock’, 8 Annual Review of Financial Economics 2016, p. 1-24.
 For an excellent quasi psychoanalysis of Navinder’s mind, see L. Vaughan, Flash Crash. A Trading Savant, a Global Manhunt and the Most Mysterious Market Crash in History, London: William Collins 2020.
 See Recital 6 of MAD II.
 See Recital 12 of MAD II.
 See Recital 10 of MAD II.
 See Recital 7 of MAD II.